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Turmoil in Iraq and Ukraine is Roiling the Energy Markets

Robert Mitkowski
| June 19, 2014

The oil and natural gas markets have yet more concerns in that fighting in Iraq and Ukraine is undermining the perception that supplies are ample and fairly secure.

Just when it seemed as though rising supplies of shale oil in the United States might push oil prices lower, Russia’s takeover of Crimea and its designs on Ukraine provided another level of support for the oil market. As if that wasn’t enough, Iraq’s descent into chaos has lifted oil prices in recent weeks, with the potential for a spike higher should the nation’s southern oil fields be shut down.

Regarding Russia, the fear is that widening sanctions against Russia will escalate to the point where oil supplies from the former Soviet Union are disrupted. Granted, we are not to that point yet, and may never get there. But oil traders are rightfully on edge.

It is not only oil supplies that are at risk. Natural gas shipments from Russia to Europe are being threatened. Russia pipes in about one-third of Europe’s natural gas, with much of the continent’s southern tier fed by pipelines that traverse Ukraine. At the same time, Ukraine’s own gas supply, once purchased at a discount from Russia, has been shut down. That, in turn, could potentially disrupt supplies headed elsewhere in Europe.

Driving a stake through hopes that the situation in Ukraine might soon settle down was a recent referendum on self rule in eastern Ukraine that rebels said received overwhelming support. The vote seemed to dash hopes of a quick and easy reconciliation.

Meantime, the international community’s response to Russia’s apparent provocation of unrest within Ukraine is a widening set of sanctions. At first, sanctions against Russia were aimed at individuals, but the European Union has subsequently targeted a pair of Crimean companies with coercive measures. We note, though, that sanctions aimed at Russia have yet to include the energy sector, for practical reasons, since Europe needs the imported fuel for its economy. Iraq’s meltdown makes Russia’s oil production even more important.

Ultimately, there may be too much at stake for Russia to risk losing the goodwill of its oil and natural gas export customers and, hence, growth for its energy-export-dependent economy. Officials in Europe are already seeking to diversify the region’s natural gas supply, since Russia is seen in some quarters as a necessary, but not completely reliable, partner. Moves to build gas storage facilities and construct pipelines between countries to move gas are under way. European nations would be forced to look elsewhere for gas if supply lines through Ukraine are completely shut down, possibly driving up prices.

For its part, officials in Russia were recently able to diversify their natural gas export business through the signing of a major long-term deal with China. But the completion of construction to make the deal work is a long way off and there is a feeling that Russia made price concessions.

As for the troubles in Europe, diplomatic initiatives are being vigorously pursued. The hope is that the situation in Ukraine does not spin out of control, and result in the type of Cold War standoff that prevailed for decades following the end of World War II. There is enough trouble elsewhere in the world keeping oil prices higher than they should be, given the grave situation in Iraq. Oil shipments from troubled Libya are well below full capacity, too. The lack of a resolution to problems in Ukraine, Iraq, and Libya stands to make oil prices more expensive for a while longer. As a hedge against rising prices, investors might consider purchasing shares of tried-and-true energy conglomerates, such as Exxon Mobil (XOM - Free Exxon Stock Report) or Chevron (CVX - Free Chevron Stock Report).

At the time of this article, the author did not have positions in any of the companies mentioned.